What Are the Notes to Financial Statements?

Financial Statements:

The financial statements are reports that exhibit all the company’s financial information but are supposed to be prepared in a proper structure and format in accordance with IAS 1 (International Accounting Standards).

IAS 1 provides a detailed guideline for preparing a complete set of financial statements.

These statements are accompanied by footnotes or explanatory notes that explain the financial statements’ figures and portray the statements’ true and fair views.

Four financial statements should be prepared annually at the end of each year.

  1. Statement of comprehensive income
  2. Statement of financial position
  3. Statement of changes in equity
  4. Statement of cash flows

Footnotes to financial statements:

As explained above, the notes unravel the line items reported on the financial statements. As per accounting rules and principles, the financial statements should be neat and precise.

However, it would take numerous pages to complete a single financial statement if you look at the perplexed and prolonged calculations behind the figures.

This would only create a mess and muddle up all the relevant information with jargon and computations making it inconvenient and onerous for the users to read.

Ergo, notes to the financial statements are essential for reporting purposes. Without these footnotes, it would be exasperating for the shareholders, investors, and public to judge the company’s financial stability.

The notes make the financial statement trouble-free for the readers while maintaining its legibility.

What is Included in Notes to the Financial Statements?

We could say that there are two types of footnotes. As important as it is to explain the calculations and figures of depreciation, lease terms, stock options, hedging, long-term debts, accrued liabilities, pension plans, income taxes, etc, the company is also obligated to report the accounting policies and methods it uses for valuation of inventory, revenue recognition, intangible assets, the nature of the business, start and end of the accounting period and others.

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This implies that the two types of footnotes are texts and calculations. The calculations are disclosures to the line items reported on the financial statements that are impossible to decipher independently.

For example, schedule of depreciation, schedule of lease payments, and schedule of amortization are disclosed in the notes to financial statements, and to explain the basis of these calculations we use texts to describe, in our example, the class of the assets, the purpose of those assets, the acquisition of goodwill, the usage/purpose of the intangible asset, how the value of the intangible asset was assessed, interest rate for lease payments, start and end of lease payments, etc.

The company has to report any subsequent events in the notes to financial statements.

A subsequent event is an event that occurs after the accounting period has ended but before the financial statements have been issued for the same accounting period.

The GAAP requires you to disclose any subsequent events, the conditions of which existed before the year ended.

Another instance would be contingent liabilities. These are cash outflows of uncertain amounts expected to happen at an uncertain time.

Any contingent liability shall be disclosed in the notes to financial statements since they can’t be reported on the financial statements. An example would be warranty expense.

The notes also give all specifics of operating expenses. The income statement only reports general admin expenses and selling and distribution expenses.

However, the background of operating expenses as in all the other heads of expenses (example: fuel/utilities/depreciation) included are specified in the footnotes.

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In conclusion, all the line items on the financial statements need a background explanation that must be reported for the public to understand. Notes to the financial statements do the trick for you.